October 30, 2023

October 2023 Office Market Report – Happy Halloween!


October 2023 Office Market Report


The Phoenix office market continues to navigate through an extended period of demand disruption, as evidenced by roughly 1 million SF in negative net absorption during 23Q2. Very Spooky! This brings total negative absorption to 2.1 million over the past 12 months. The pullback contributed to an increase in vacancy from 11.2% entering the pandemic to 16.1% today, the highest level since 2015. But Don’t Feel Empty Inside, rents are 15% higher today than in 19Q4, Phoenix maintains its position as a lower-cost office market. At $29.00/SF, the average office rent in Phoenix is roughly 17% less than the National Index of $35.00/SF, and the discount relative to West Coast markets is even larger with average rents in San Francisco and San Jose more than double that in Phoenix. Phoenix’s relative affordability will likely continue to attract tenants looking to relocate or expand operations in the western part of the United States without paying exorbitant rents in coastal markets.

The rapid accumulation of sublease availability underscores the difficult climate many operators are facing. The amount of space on the sublet market has surged from an average of 2.1 million SF before the pandemic to 7.7 million SF, accounting for 3.9% of the Valley’s total office inventory. Technology firms and insurance companies have been the primary driver of this upswing, often relinquishing space in newer vintage office properties in Tempe and Chandler. Meanwhile, performance has been steadier in the Camelback Corridor, supported by a deep pool of real estate, law, healthcare, and finance firms. Users in these industries tend to be more reliant on their physical footprints and sublease availability has been minimal.





After recording flat absorption in the two years since the onset of the pandemic, the Phoenix office market further weakened in 2022, a trend that intensified in the first half of 2023. The recalibration of space configurations in the wake of hybrid work models is clearly having an impact on local office fundamentals. Tenants are targeting smaller footprints as their space needs evolve with the average lease signed over the past 12 months being roughly 10% smaller than the average in 2017-19. Additionally, the market recently recorded its worst quarter of net absorption on record with nearly 1 million SF shed in 23Q2. This marks nine out of the past 12 quarters with more move-outs than move-ins, contributing to 2.1 million SF of net absorption over the past year.

The metro wide vacancy rate has climbed from 11.2% in 19Q4 to 16.1% today, and the current outlook includes additional upward movement over the short to mid-term. The availability rate, which includes available sublease inventory as well as space that is on the market but has yet to be vacated, is often a better metric to track during periods of rapid change. The availability rate for 4 & 5 Star properties has surged from about 15% in 19Q4 to 27.3% as tenants choose to relinquish large footprints in high-end offices in the East Valley. The glut of sublease space continues to weigh on the market, particularly for modern properties that were leased to expanding technology and insurance firms.





Despite facing near-term headwinds, rents in the Phoenix office market are holding up well. Even during the depths of the pandemic, Phoenix office rent growth never turned negative, continuously outpacing gains seen at the national level. Over the past 12 months, rents have increased 3.8%, compared to 1.0% for the United States. That annual rate of growth ranks Phoenix as one of the best-performing office markets in the country in terms of rent gains. Trick or Treat!

Although underlying office demand has undoubtedly shifted, many property owners have been less willing to lower rents to preserve investment value, and instead have opted for increased concessions or higher TI allowances. Concessions of six months of free rent for a five-year lease term are common though discounts are lower for smaller-footprint leases.




The bulk of deliveries so far this year were for medical office properties. In January, RED Development finalized the construction of a 70,000-SF facility for a new Banner Health Center plus. The single-tenant medical office building is the latest addition to The Grove, an ultra-luxury mixed-use development in the highly sought-after Camelback Corridor Submarket. Builders completed work on the other office component in late 2022. The 181,500- SF office received considerable leasing demand signing Sendoso, Clayco, and JLL, among others, on as tenants. Banner Health also opened a new $54 million sports medicine office in Central Scottsdale in May. The three-story 80,000-SF building is located at the Riverwalk entertainment district near Talking Stick Resort and provides care to athletes at all levels with services including orthopedic surgery, concussion care, physical therapy, and medical imaging.

Office development is also heating up in the West Valley. Last year, builders finished work on the first phase of GSQ, a large mixed-use project that Globe Corporation is conducting in partnership with the City of Goodyear. It includes Gen 1 at GSQ, a 104,000-SF office, as well as a new 125,000-SF city hall for Goodyear. Upon full build-out, GSQ will include a two-story library and a 2- acre community park as well as space for restaurants, retail, and entertainment. Speculative 4 & 5 Star office development is very limited in the West Valley, attracting interest from tenants looking for new high-quality options in the region. The new GSQ development is reportedly 60% leased with expectations to be fully occupied by 2024.






The rise in interest rates, vacancies, and sublet space is continuing to weigh on transaction activity as buyer-seller pricing expectations remain at odds. Approximately $357 million in office assets traded in 23Q2, the weakest second quarter of sales volume in over a decade. Higher capital costs and weaker projections for future performance have put upward pressure on cap rates, weakening property values. Moving forward, elevated interest rates together with broader economic uncertainty are expected to keep deal flow slow for the remainder of the year.

CoStar is currently tracking more than $800 million in CBMS loan maturities coming due for Phoenix office assets through 2025. Lower-quality properties with higher vacancies could face challenges when these loans mature, raising questions about default risk and discount opportunities. While some investors have been anticipating an increase in distressed sales activity, the trend has yet to meaningfully materialize. Unlike at the national level, the delinquency rate for Phoenix CMBS office loans remains below pre-COVID levels. Additionally, during the Great Recession, it often took several years for troubled properties to fully work their way through the distressed sale process and come to market. As a result, the timeline and magnitude of these types of transactions remain unclear.





Phoenix remains one of the nation’s better-performing markets for employment growth recording more than 42,700 job additions in the trailing 12-month period ending July 2023. The labor market now has 154,800 more jobs than before the pandemic, the fourth-largest gain in the nation. The local economy was highly resilient during the pandemic, thanks to a diversified employment base across a broad range of industries. Metro Phoenix lost about a quarter million positions in March and April 2020 but by July 2021, Phoenix fully regained those losses, which was nearly a full year ahead of the U.S. This marks a stark contrast to its protracted recovery from the global financial crisis, when Phoenix didn’t recoup its job losses until well after the broader nation did.

The valley’s diversity of industries has helped sustain the region’s long-term stability. Phoenix was synonymous with cheap labor and land that attracted call centers and back-office operators more than a decade ago. The economy depended on industries associated with household growth – construction, lending, brokerage, tile and cabinet manufacturers, etc. Because of its past reliance on housing, Phoenix was among the hardest-hit metros during the Great Recession; the market lost more than 240,000 jobs, 25% of which were in the construction industry alone. Phoenix recovered from the Great Recession about two years after the U.S. The companies that Phoenix is attracting have evolved, and the market has emerged as a hub for advanced manufacturing, aerospace, logistics, technology, life sciences and finance.



While the office sector continues to struggle with vacancy levels, the rental rates in Phoenix continue to hold strong. We have personally seen an uptick in office leasing amongst smaller businesses and, as people trickle back into the office scenario, we expect that to continue. If you have any questions about the office market or the economy, please do not hesitate to contact us.


Happy Halloween and thank you from Team Trbo!

Craig Trbovich and Niki Saunders


Source: CoStar

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About Craig
Craig Trbovich is a commercial real estate broker with Commercial Properties, Inc. in Scottsdale, Arizona, specializing commercial sales and landlord representation in the Phoenix Metro Area. He applies 35 years of experience as a CPA and an investor to help other owners and investors maximize their returns, bringing a strong financial and tax perspective to all aspects of commercial real estate ownership. His strengths include sales and leasing, as well as an in-depth knowledge of the development community and the local market.